Fannie Mae (FNM) and Freddie Mac (FRE) won’t be allowed to fail, and Bush Administration officials are discussing ways to make sure they won’t. But none of the options look good for shareholders. The stockholders’ only hope at this point is that the Fannie / Freddie collapse is just a market panic and that the two companies are adequately capitalised. This seems unlikely.

Government takeover. The companies would be put in a “conservatorship” and run by their regulator (OFHEO). In this scenario, the stocks of FNM and FRE would be “worth little or nothing,” says the NYT. Also, any losses on mortgages they own or guarantee would be paid by taxpayers.

Explicit guarantee of the $5 trillion of mortgages owned or guaranteed by FNM and FRE. This would set a new standard for the word “bailout.” It would also basically double the size of the US’s public debt. FNM and FRE could conceivably do relatively well in this scenario, but it’s unlikely that the government would allow them to do so. Given the backlash the Fed and Treasury were hit with after “bailing out” Bear Stearns at $2/share, it’s unlikely FNM and FRE shareholders would get much.

Other possibilities that are likely to be considered (from this WSJ overview):

Fed buys portion of FRE/FNM debt or mortgage-backed securities. This would reduce their leverage and bolster their capital ratios. Again, in theory, stock investors could be OK, but we suspect the Fed would only agree to do this on the condition that shareholders got hammered (as with Bear Stearns.)

Fed could make huge, long-term loans to the companies. Again, in theory, stock investors could do OK. But optics are important, so they most likely won’t.

Treasury buys FNM and FRE stock. This is a partial version of the takeover scenario above: The government just makes a massive equity infusion to shore up capital. This would lead to major dilution of current shareholders, but likely not a total wipeout.

Equity investment by private investors. It’s still possible that Fannie and Freddie could survive without a government lifeline. This would be the best option for current shareholders, but they would still get socked by dilution. Given the amount of capital needed and the panic around these companies, it’s also unlikely that they would be able to raise the money quickly and without the dilution being severe.

The only scenario in which FNM and FRE investors don’t get further bludgeoned, in other words, is the “just a temporary market panic” scenario. In this scenario, FNM and FRE’s insistence that they have plenty of capital is not a hallucination, the market realises its error, and the stocks skyrocket. Investors who take this view include Bill Miller, the once-legendary Legg Mason fund manager who has been buying FRE all the way down.